2. Annuities and Sinking Funds
Chapter 13
Annuities and Sinking Funds
McGraw-Hill/Irwin
Copyright © 2003 by The McGraw-Hill Companies, Inc. All rights reserved.

3. Annuities and Sinking Funds
#13
Annuities and Sinking Funds
Learning Unit Objectives
LU13.1
Annuities: Ordinary Annuity and Annuity Due (Find Future Value)
Differentiate between contingent annuities and annuities certain
Calculate the future value of an ordinary annuity and an annuity due manually and by table lookup

4. Compounding Interest (Future Value)
Term of the annuity - the time from the beginning of the first payment period to the end of the last payment period.
Annuity - A series of payments
Present value of an annuity - the amount of money needed to invest today in order to receive a stream of payments for a given number of years in the future
Future value of annuity - the future dollar amount of a series of payments plus interest

5. Figure 13.1 Future value of an annuity of $1 at 8%
$1.00
End of period

6. Figure 13.1 Future value of an annuity of $1 at 8%
$2.08
$1.00
End of period

7. Figure 13.1 Future value of an annuity of $1 at 8%
$3.25
$2.08
$1.00
End of period

8. Classification of Annuities
Contingent Annuities - have no fixed number of payments but depend on an uncertain event
Annuities certain - have a specific stated number of payments
Life Insurance payments
Mortgage payments

9. Classification of Annuities
Annuity due - regular deposits/payments made at the beginning of the period
Ordinary annuity - regular deposits/payments made at the end of the period
Jan. 31 Monthly Jan. 1
June 30 Quarterly April 1
Dec. 31 Semiannually July 1
Dec. 31 Annually Jan. 1

10. Tools for Calculating Compound Interest
Rate for each period (R) Annual interest rate divided by the number of times the interest is compounded per year
Number of periods (N) Number of years times the number of times the interest is compounded per year
If you compounded $100 each year for 3 years at 6% annually, semiannually, or quarterly What is N and R?
Periods
Rate
Annually: 6% / 1 = 6%
Semiannually: 6% / 2 = 3%
Quarterly: 6% / 4 = 1.5%
Annually: 3 x 1 = 3
Semiannually: 3 x 2 = 6
Quarterly: 3 x 4 = 12

11. Calculating Future Value of an Ordinary Annuity by Table Lookup
Step 3. Multiply the payment each period by the table factor. This gives the future value of the annuity
Step 2. Lookup the periods and rate in an ordinary annuity table. The intersection gives the table factor for the future value of $1
Step 1. Calculate the number of periods and rate per period

12. Table 13.1 Ordinary annuity table: Compound sum of an annuity of $1

13. Future Value of an Ordinary Annuity
Find the value of an investment after 5 years for a $2,000 ordinary annuity at 9%
N = 5 x 1 = 5
R = 9%/1 = 9%
x $2,000
$11,969.40

14. Future Value of an Ordinary Annuity
Find the value of an investment after 5 years for a $2,000 ordinary annuity at 9%
N = 5 x 1 = 5
R = 9%/1 = 9%
x $2,000
$11,969.40

15. Future Value of an Ordinary Annuity
Find the value of an investment after 5 years for a $2,000 ordinary annuity at 9%
N = 5 x 1 = 5
R = 9%/1 = 9%
x $2,000
$11,969.40

16. Future Value of an Ordinary Annuity
Find the value of an investment after 5 years for a $2,000 ordinary annuity at 9%
N = 5 x 1 = 5
R = 9%/1 = 9%
x $2,000
$11,969.40

17. Future Value of an Ordinary Annuity
Find the value of an investment after 5 years for a $2,000 ordinary annuity at 9%
N = 5 x 1 = 5
R = 9%/1 = 9%
x $2,000
$11,969.40

18. Calculating Future Value of an Annuity Due by Table Lookup
Payment is made at the beginning of the period.
Step 4. Subtract 1 payment from Step 3.
Step 3. Multiply the payment each period by the table factor.
Step 2. Look up the periods and rate in an ordinary annuity table. The intersection gives the table factor for the future value of $1
Step 1. Calculate the number of periods and rate per period. Add one extra period.

19. Future Value of an Annuity Due
Find the value of an investment after 5 years for a $2,000 annuity due at 9%
N = 5 x 1 = = 6
R = 9%/1 = 9%
x $2,000
$15, $2,000
$13,046.60

20. Future Value of an Annuity Due
Find the value of an investment after 5 years for a $2,000 annuity due at 9%
N = 5 x 1 = = 6
R = 9%/1 = 9%
x $2,000
$15, $2,000
$13,046.60

21. Future Value of an Annuity Due
Find the value of an investment after 5 years for a $2,000 annuity due at 9%
N = 5 x 1 = = 6
R = 9%/1 = 9%
x $2,000
$15, $2,000
$13,046.60

22. Future Value of an Annuity Due
Find the value of an investment after 5 years for a $2,000 annuity due at 9%
N = 5 x 1 = = 6
R = 9%/1 = 9%
x $2,000
$15, $2,000
$13,046.60

23. Future Value of an Annuity Due
Find the value of an investment after 5 years for a $2,000 annuity due at 9%
N = 5 x 1 = = 6
R = 9%/1 = 9%
x $2,000
$15, $2,000
$13,046.60

24. Investing for the Future
Deb has just started a new job where her employer will match contributions she makes to 401(k) retirement plan. Deb decides to invest $100 per month, with deposits made on a quarterly basis. The company investment plan compounds interest quarterly, and is currently showing a 6% yield. How much will accumulate in Deb’s account after 12 years if this is an ordinary annuity?
N= 4 * 12 = 48
R = .06/4 = .015
f =
FV = 600 * = 41,738.94

25. Investing for the Future
Deb has just started a new job where her employer will match contributions she makes to 401(k) retirement plan. Deb decides to invest $100 per month, with deposits made on a quarterly basis. The company investment plan compounds interest quarterly, and is currently showing a 6% yield. How much will accumulate in Deb’s account after 12 years if this is an annuity due?
N= 4 * 12 =
R = .06/4 = .015
f =
FV = 600 * = 42, – 600 = 42,365.04

26. Work Drill problems 13-1 to 13-4, page 311
Assignment
Read chapter 13 pages 299—305
Work Drill problems 13-1 to 13-4, page 311

27. Annuity Review 1
Doug Anders gets paid salary plus commission. His commission is paid at the end of each quarter, so he has decided to invest $500 in a mutual fund each quarter. The fund pays 8% interest compounded quarterly. How much will Doug have accumulated at the end of 8 years?
N = 32 R= 2%
Annuity factor =
Ordinary annuity = x 500 =

28. Annuity review 2
Nancy Smith receives a $1,250 alimony payment at the beginning of each month. She wants to save for a down payment on a home. If she can save one-half of the alimony each month, and invest it in a fund which pays 6% interest compounded monthly, how much will she have saved after 4 years?
N = R = .5%
annuity factor =
Annuity due = x 625 = – 625
Annuity due =

29. Annuities and Sinking Funds
#13
Annuities and Sinking Funds
Learning Unit Objectives
LU13.2
Present Value of an Ordinary Annuity (Find Present Value)
Calculate the present value of an ordinary annuity by table lookup and manually check the calculation
Compare the calculation of the present value of one lump sum versus the present value of an ordinary annuity

30. Figure 13.2 - Present value of an annuity of $1 at 8%
$2.58
End of period

31. Figure 13.2 - Present value of an annuity of $1 at 8%
$2.58
$1.78
End of period

32. Figure 13.2 - Present value of an annuity of $1 at 8%
$2.58
$1.78
$.93
End of period

33. Calculating Present Value of an Ordinary Annuity by Table Lookup
Step 3. Multiply the withdrawal for each period by the table factor. This gives the present value of an ordinary annuity
Step 2. Look up the periods and rate in an ordinary annuity table. The intersection gives the table factor for the present value of $1
Step 1. Calculate the number of periods and rate per period

34. Table 13.2 - Present Value of an Annuity of $1

35. Present Value of an Annuity
Duncan Harris wants to receive a $5,000 annuity payment each 6 months for 5 years. Interest on the annuity is 8% semiannually. Duncan will make withdrawals at the end of each year. How much must Duncan invest today to receive a stream of payments for 5 years.
Interest ==>
Payment ==>
Payment ==>
Payment ==>
N = 5 x 2 = 10
R = 8%/2 = 4%
x $5,000
$40,554.50
Payment ==>
Payment ==>

36. Present Value of an Annuity
Duncan Harris wants to receive a $5,000 annuity payment each 6 months for 5 years. Interest on the annuity is 8% semiannually. Duncan will make withdrawals at the end of each year. How much must Duncan invest today to receive a stream of payments for 5 years.
Interest ==>
Payment ==>
Payment ==>
Payment ==>
N = 5 x 2 = 10
R = 8%/2 = 4%
x $5,000
$40,554.50
Payment ==>
Payment ==>
End of Year 5 ==>

37. If I win the Lottery…

38. If I win the Lottery…
Amanda must decide how she wishes to take her lottery winnings, which amount to $1.5 million. She may take a lump sum payment now or her second option is to take an annual payment of $50,400 each year for 20 years, less taxes. Ryan is trying to convince her to take it all now, in one lump-sum. How much would Amanda receive before tax if she follows Ryan’s advice, at a 4% investment rate, annual compounding for 20 years?
N = 20
R = 4%
PV = * = $684,951.12

39. Lump Sums versus Annuities
Karen Jones made deposits of $1,000 to Fleet Bank, which pays 6% interest compounded annually. After 4 years, Karen makes no more deposits. What will be the balance in the account 10 years after the last deposit
N = 10 x 1 = 10
R = 6%/1 = 6%
x $4,374.60
$7,834.03
Future value of a lump sum
N = 4 x 1 = 4
R = 6%/1 = 6%
x $1,000
$4,374.60
Future value of an annuity

40. Work Drill problems 13-5 to 13-7, page 311
Assignment
Read chapter 13 pages
Work Drill problems 13-5 to 13-7, page 311

41. Annuity Review 3
Susan has started a Roth IRA. She plans to deposit $400 per quarter at the end of each quarter into the fund which pays 6% interest. Tax laws permit Susan to withdraw up to $10,000 for a new home deposit after a minimum of 5 years. How much will Susan have accumulated after the 5 year period?
N = 5 x 4 = 20 R = 6% / 4 = 1.5%
fv = 400 x
fv =

42. Annuity review 4
John has just inherited a large sum of money. He wants to set up an educational trust for his daughter. She will start college next year, and he plans on having $5,000 available to pay her educational costs each semester for 5 years. If John can invest the money at 8% compounded semiannually, how much should he put in the trust for his daughter now?
N = 10 R = 4%
pv = 5000 x
pv =

43. Annuity Review 5
The YMCA has just received an endowment of $75,000 per year for 4 years, receiving it at the beginning of each year. They plan to invest this in a building fund which will yield 5% annually. At the beginning of the 5th year, they will invest the total amount in a fund for 6 more years, earning 8% quarterly. How much be available after 10 years?
Annuity due: N = R = 5%
75000 x = 414,420 – = 339,420
Lump sum: N = 24 R = 2%
339,420 x = 545,923.13

44. Annuities and Sinking Funds
#13
Annuities and Sinking Funds
Learning Unit Objectives
LU13.3
Sinking Funds (Find Periodic Payments
Calculate the payment made at the end of each period by table lookup
Check table lookup by using ordinary annuity table

45. Sinking Funds (Find Periodic Payments)
The amount of a periodic payment which must be made at regular intervals in order to accumulate a desired future amount with compound interest.
Bonds
Sinking Fund = Future x Sinking Fund
Payment Value Table Factor

46. Table 13.3 - Sinking Fund Table Based on $1

47. Future Value of an annuity table
Sinking Fund
Check:
To retire a bond issue, Randolph Company needs $150,000 in 10 years. The interest rate is 8% compounded annually. What payment must Randolph Co. make at the end of each year to meet its obligation?
$10,350 x
149,936.30*
N = 10, R= 8%
Future Value of an annuity table
N = 10 x 1 = 10
R = 8%/1 = 8%
x $150,000
$10,350
* Off due to rounding

48. If I win the Lottery!!!
John wants his winnings spread out so he doesn’t spend it all at once. If he wins the megabucks jackpot of $5 million, how much will he receive semi-annually for 20 years, assuming a 4% compound rate?
SF = 5,000,000 * f
SF = 5,000,000 * .0166
SF = $83,000 before taxes

49. Work Drill problems 13-8 to 13-10, page 311
Assignment
Read chapter 13 pages
Work Drill problems 13-8 to 13-10, page 311

50. Decisions, decisions, decisions …
How do I know what compound interest factoring table to use for a problem?

51. Compound Interest to find Future Value (chapter 12)
Given: a single investment amount
What will $1 today grow to in the future
Present value is known
key words:
invest today
future amount
at the end of X years

52. Compound Interest to find Present Value (chapter 12—col 2)
Given: a single future amount
What you need today to grow to $1 in the future
Future value is known
key words:
how much today
present value

53. Annuity—Future Value
to find Future Value of several payments made (chapter 13)
Amount of Annuity (col. 3)
multiple amounts grow to one future amount
What will several $1 deposits grow to in the future
Given: payment amounts
key words:
annuity
end of X years
Payments, Deposits
Ordinary Annuity
Annuity Due

54. Annuity—Present Value
to find amount needed today to receive several equal payments (chapter 13)
Present Value of Annuity (col. 4)
Given: amount of multiple payments
What will you need today (single amount) if you wish to make multiple withdrawal over future periods
key words:
how much today
original amount
present value

55. Annuity—Sinking Fund to find amount of each equal payment (chapter 13)
Sinking Fund (col. 5)
How much is the payment?
Given: Future amount needed
key words:
needed payments
deposits needed
sinking fund payment

56. Review Problem 1
John Tobn made deposit of $650 at the end of each year for 5 years. The rate if 8% compounded annually. What is the value of John’s annuity at the end of 5 years?
What type of problem?
Ordinary annuity
N = 5
R = .08
650 x =

57. Review Problem 2
Jim promised to pay his son $200 semiannually for 6 years. If Jim can invest his money at 8% in an ordinary annuity, how much must Jim invest today to be able to pay his son.
What type of problem?
Annuity—present value
N = 12
R = .04
200 * = $

58. Review Problem 3
Joyce has decided to invest $500 quarterly for 5 years in an ordinary annuity at 12%. As her financial advisor, could you calculate for Joyce the total cash value of the annuity at the end of year 5?
What type of problem?
Ordinary annuity
N = 20
R = 3%
500 * = 13,435.20

59. Review Problem 4
Jack invests $850 semiannually at 10% for 9 years at the beginning of each year. What will be the cash value of this annuity due at the end of the ninth year?
What type of problem?
Annuity due
N = 19
R = 5%
850 * = $25, – 850 = 25,108.07

60. Review Problem 5
Moller Associates must repay $500,000 in bonds in 10 years. The company wants to set up a sinking fund to accumulate the needed amount. Assuming a rate of 10% compounded semiannually, what amount must be paid into the fund each period?
What type of problem?
Sinking fund
N = R = 5%
500,000 * = 15,100
Check it:
15100 * 33,0659 = 499,295.10

61. Review Problem 6
Jane’s daughter, Amanda, is now two year’s old. Jane is planning a college fund to pay tuition costs of $5000 per semester. Amanda will start college in 16 years, and Jane will pay for four years of school. Jane is planning on setting up a mutual fund which yields 7% compounded semiannually, using money she inherited. How much must Jane invest into the mutual fund to meet the needed tuition payments?
What is this?
Present value of an annuity and sinking fund
PV annuity: 5000, 4 years, semiannual, 7%
PV annuity = 5000 x = 34, in 16 years
PV lump sum for 16 years at 7% semiannual
PV = 34,369 * = 1,

62. Review Problem 7
Wes wants to retire as a millionaire. How much must Wes save per year for 30 years, if he can invest in a mutual fund which pays 9% compounded annually?
What is this?
Sinking fund
SF = 1,000,000 x .0073
SF deposit = 7300 per year